China Producer Price Deflation Continues

China’s factory-gate prices have fallen for 14 months in a row because of huge overcapacity in many industries, said the Wall Street Journal in this article.

“Producer prices – a measure of prices of goods before they reach consumers – dropped 2.4% in April, the sharpest decline since October, paced by particularly steep falls in the metals and chemicals sectors,” wrote the WSJ.

“That could add to concerns about China’s slowdown in growth, say economists, because falling producer prices make it tougher for makers of industrial goods and commodities to make profits, pay off their debts and pay their suppliers on time.”

The ICIS Petrochemical Index (IPEX) Northeast Asia sub-index for May (see the above chart), reflects the WSJ analysis. Prices in the region fell by 5.6% over April due to weaker olefins and butadiene markets.

Falling producer prices might well undermine the argument that the surge in bank lending during Q1 will result in stronger economic growth in H2. If companies are too busy paying off debts, and dealing with falling prices caused by overcapacity, a loans-fuelled rise in output seems unlikely.

And Barclays, in the same WSJ article, said that some of the first-quarter lending was used to serve existing debt, as we have discussed before.

“The deflation in the industrial sector reflects overcapacity in a number of major Chinese industries including steel, coal, glass, aluminium, solar panels and cement,” continues the WSJ.

The problem is so great in solar panels that higher-quality solar grade ethylene vinyl chloride acetate (EVA), used to make the encapsulants for the panels, is being sold at discounted prices for training-shoe and other lower-value applications, said an industry consultant on the sidelines of last week’s Asia Petrochemical Industry Conference (APIC).

And last week, The European Commission decided to impose preliminary antidumping duties of 47% on Chinese solar panel imports. Last year, the US imposed antidumping tariffs of more than 30% on Chinese shipments.

We worry that trade protectionism will in general be on the rise as China’s economic weakness continues.

Overcapacity is a problem across many petrochemicals, said several delegates at last week’s APIC.

Purified terephthalic acid (PTA) is a good example of oversupply. Asian operating rates have fallen below 70% as a result of demand growth of 5-6% in 2013 versus capacity growth of 21%, said Becky Zhang, the ICIS fibre intermediates pricing editor for Asia.

Despite their concerns about oversupply, APIC delegates, as we said on Monday, believed that surpluses would be absorbed as a result of China returning to strong growth by 2015.

Reasons to doubt this theory include:

*China’s inability to export its way out oversupply, as it has done in the past, because of weak Western economies.

*The inability of the government to launch a stimulus package on the scale of 2009 because of bad debt problems and diminishing returns from the investment growth model.

A further negative for growth is that painful restructuring across many industries seems likely, including in aluminium where 90% of producers are said to be loss making.

Previously, the government was reluctant to streamline inefficient industries because of the danger of a sharp rise in unemployment.

But now the job market is tight, giving the government freedom to close down loss-making manufacturers.

Industrial restrucutring will likely also take place as part of China”s attempt to to avoid the middle-income trap.

Low-value, loss-making companies will be strategically shut down as iinnovative, higher-value companies are encouraged to start-up.